The cash method and accrual method of accounting are two different methods used to record accounting transactions in your business. The basic difference between the two methods is in the timing of transaction recording, and in turn of GST reporting. When aggregated over time, the results of the two methods are approximately the same. A brief description of each method follows:
- Cash method – The Cash Method of accounting is recognising income and expenses in your business when they actually occur. Revenue is recorded when cash is received from customers, and expenses are recorded when cash is paid to suppliers and employees.
- Accrual method – The Accrual Method of accounting is recognising the income and expenses when you issue the invoice or receive the invoice from a supplier, even though you haven’t been paid or you haven’t paid the bill. Revenue is recorded when it is earned (invoiced) and expenses are recorded when consumed (billed)
Example 1) – You receive a bill from a supplier on 20th March, but don’t pay the invoice until 15th April. If you use the cash accounting method you will not account for the bill in expenses until April, and the GST would be claimed in April. If you use the accrual method you account for and claim tax for the bill in March
Example 2) – You issue an invoice to a customer on 11th January, but don’t receive payment until 2nd March. If you use the cash accounting method you will not account for the bills income until March, and the GST would not be paid until March. If you use the accrual method you account for and pay GST in January (before you receive money from the customer).
Advantages of Cash Accounting:
- Cash Accounting is a simple system that tracks your businesses cash flow, for quite a few businesses that is all they are interested in doing.
- If you have a small business that mostly handles cash then the Cash Method is suited to your business.
- Using the Cash Method makes it easier to know at all times what is in your bank
- The Cash Method is used by businesses who need their bookkeeping done to do their BAS’s and Tax Returns.
Disadvantage of Cash Accounting:
- Using the Cash Method doesn’t give you the true picture of your business. You also don’t know how much you owe or how much is owed to you. A Profit & Loss Report need sto be viewed together with the Balance Sheet.
Advantages of Accrual Accounting
- Accrual Accounting is suited to businesses that don’t get paid immediately. They issue invoices on completion of their products or services and receive payment for them in the future sometime. They also purchase products and services on account with their suppliers and pay them in the future.
- The Accrual method tracks your true financial position. It captures what money is owed to you and what money you owe to others.
- If you have to deal with lots of contracts or large amounts of money, using the Accrual method may help with this.
Disadvantages of Accrual Accounting
- The disadvantages of Accrual Accounting are that it is complicated and you need to have an in-depth knowledge of bookkeeping methods or have a professional undertake the work for you if you are going to use this method.
- GST must be paid on amounts you invoice before payments are received.
Cash, Accrual & GST
- Before deciding what method you need to use, you also need to understand how each method is used when it comes to GST and lodging your BAS’s with the ATO. Your qualified Accountant can advise you on this.
- If you are a Small Business with an annual turnover of less than $75,000 you do not have to register for GST or collect GST, therefore you can choose whatever accounting method you like.
- If you are a Business with an annual turnover over $75,000 and under $2,000,000 you must collect and pay GST using the Cash Method. You must always lodge your BAS’s using the Cash Accounting Method.
- If your Business has an annual turnover of over $2,000,000 then you must collect and pay GST using the Accrual Method. It is also wise to use the Accrual Method to do your bookkeeping as well as it gives you a way better understanding of your business.
- The cash method is available for Sole Traders and Companies with a turnover of less than $10 million of sales per year It is easiest to account for transactions using the cash method, since no complex accounting transactions such as accruals and deferrals are needed. Given its ease of use, the cash method is widely used in small businesses.
- The accrual method is used by all larger companies when sales exceed $10 million. Also, a company’s financial statements can only be audited if they have been prepared using the accrual method. However, unless a statement of cash flows is included in the financial statements, this approach does not reveal the ability of a business to generate cash.
Remember always view your Profit & Loss Reports, and other reports, in the Accounting method your business is using – Cash or Accrual (See Difference between Cash and Accrual Accounting Sheet)